Throughout history there have been many parables and stories that discuss the issues that arise when proper investments are not made to protect assets and infrastructure. In this issue of TransActions, we are going to discuss how conducting a water rate study can provide value to the utility system. Here is an example to consider: A water utility system has kept its rates low, with no increases over the last 10 years, but inflationary pressure and increased maintenance costs have reduced cash reserves to the bare minimum and the system is barely “breaking even”. For various reasons, large capital expenditures will soon be needed to ensure a safe and reliable supply of water for the system’s customers and that will require a significant annual revenue increase. Additionally, the utility manager understands that hiring a qualified consultant to perform a water rate study will require a significant amount of the remaining cash reserves. The utility manager knows that water rates will already be increasing as a result of the capital expenditures. So, is spending the additional money for a water rate study justified?
The initial cost of conducting a water rate study may seem daunting to utility managers, especially for a system dedicated to keeping costs as low as possible or when the solution seems as easy as increasing current water rates by whatever percentage will result in the desired revenues. However, much like an iceberg, the most visible benefit of a rate study – the change in rates – represents only a small portion of the benefits that a typical water utility receives when conducting a rate study. The other benefits ultimately help the utility deliver what customers want – a safe and reliable water supply at a fair cost with no surprises. Let’s take a look at some of these other benefits.
1. Provides a Plan
A water rate study does more than provide a number to plug into the water tariff, it will also provide a plan going forward, based on the water system’s capital needs over the next five years. Costs to run the system will inevitably go up, and investment in the system – whether cash or debt funded – will be necessary. Instead of reactive rate increases, a rate study provides a methodical plan for responding to cost pressures, helping to avoid large increases that will result in rate shock for retail customers. When are increases necessary and how much do rates need to increase? A rate study provides the answers to these questions and a road map to the revenues needed for the water utility system. Not only will this assist the utility with planning, but it can be presented to lenders and other utility stakeholders as a comprehensive and transparent plan. In addition, the rate study and resulting plans can be presented in customer communications in order to assist them with anticipating future impacts and understanding why future increases will be taking place.
2. Evaluates Current Rate Structure & Impacts of Rate Increases
A basic rate study includes an evaluation of the water utility’s current rates. Do the consumption tiers still make sense based on current consumption patterns and best practices? Is the proportion of revenue collected through fixed rates appropriate or should they be raised or lowered? A rate study will provide the ability to evaluate the impact of potential changes on revenues and retail customer’s water bills. Instead of assessing impacts of any proposed increase on a theoretical “average” retail customer, it is important to conduct an analysis of rate increases based on actual usage levels. Doing this allows the utility to assess the real impact on retail customers’ charges and ensures that the increase is fairly borne by all users of the system. Going beyond that can be necessary if the water utility needs to determine the impacts on specific retail customers, such as large industrial customers, where identifying specific usage patterns that result in larger increases will help mitigate unfair cost
3. Third-Party Evaluation of Water Utility’s Financial Condition
A water rate study should include an evaluation of a utility’s debt service coverage levels, capital reserves, and other capital needs and incorporate them into the water rate recommendations. This will enhance a utility’s long-term financial sustainability and ensure that the utility will meet any internal or external financial targets or covenants. In addition to providing more financial stability, the resulting water rate schedule potentially allows the utility to obtain lower-cost funding for system projects by showing bankers/lenders that the rate plan already includes additional revenue to cover the cost of debt to improve the water system.
4. Allows Utility Staff to Focus on Running the Water Utility
When a water utility hires an outside consultant to perform a water rate study, it is often understood and expected that the consultant will be familiar with what is required in the rate study, has the knowledge of the appropriate financial modeling for water utility systems, and the experience to design appropriate/fair water rate schedules. What is often overlooked or not accounted for is the qualitative benefits of allowing the water utility’s staff to continue focusing on their primary jobs and responsibilities at the utility. Performing in-house studies can take even longer and ultimately cost more than hiring an outside rate consultant because utility staff must determine what documents are needed, create and maintain a rate model, stay informed about new rate designs or competitive situations, determine how costs should be allocated to retail customer classes, and determine how water rates should be designed to recover the required revenue. At each step, decisions must be made on which of several accepted methodologies is most appropriate and then the staff have to be prepared to present/defend those recommendations to the utility’s stakeholders and be prepared to manage potential political considerations. Furthermore, because the rate study is not the utility staff’s full-time responsibility, it is usually difficult to maintain a tight schedule because the staff have many responsibilities and priorities to juggle. Due to the time between water rate studies, the knowledge obtained during this process is often not maintained in the water utility, leading to the same research and processes being conducted the next time a water rate study is necessary.
5. Provides and Expert to Rely On
Water rate increases – much like home buying or legal proceedings – can be complex and involve numerous utility stakeholders, some with differing goals and levels of involvement. In a rate increase, everyone – from the Board of Directors to utility staff, largest retail customers to the smallest – will have pertinent questions about the process, why the rate increase is necessary, and what the impact will be on them. The water rate consultant can help address these questions and can also assist with appropriate messaging for the rate increase to ensure all stakeholders are apprised of the circumstances and understand that any rate increases are needed to ensure the safety and reliability of the system. Additionally, the water rate consultant may recognize opportunities related to their work in the industry, such as potential eligibility for grants or low-cost debt funding (such as Drinking Water State Revolving Funds or State Water Implantation Funds), or lower cost alternatives for services that the water utility is currently using. While recognition and discussion of these opportunities is typically outside of the official scope of a conventional water rate study, qualified rate consultants are always prepared to bring these items to the client’s attention.
The upfront expense of a rate study may seem daunting at first, but the study ultimately provides the utility’s governance, staff and customers with what matters the most – fair and justified rates that cover the cost of running the water utility, while avoiding large rate increases and the associated impact on customer bills. Relying on an expert to perform the study allows you and your staff to concentrate on running the utility, saving time and money, while also bringing in expertise that allows discovery of issues and opportunities that may not be otherwise be recognized. It also guarantees that the new rates will cover the full cost of providing service and incorporate the latest best practices of rate design. Conducting a rate study may not seem as essential of an investment as compared to new pipelines or a new pump, but it is a prudent management tool that can provide tremendous benefits to the water utility. Furthermore, once you have a solid rate study and a rate plan in hand, you can build on it for the future making future financial planning that much easier!